3.

2 Business Profit Tax

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 Chapter Contents

Overview of Business profit Tax

Legal form of businesses and taxable entities

Categories of Business taxpayers in Ethiopia

Tax accounting methods

Tax rates and other legal provisions on Business Profit Tax

Deductible Expenses

Non-Deductible Expenses

Exemptions from Business Profit Tax

Accounting for business income tax
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 Overview
Relevant Laws: Proclamation No. 286/2002,
Regulation No. 78/ 2002; Proclamation No. 608/ 2008
Business or Trade: means any industrial, commercial,
professional or vocational activity or any other activity
recognized as trade by the Commercial Code of Ethiopia
and carried on by any person for profit.
Two Types of Businesses:
Bodies (Organizations):
Others: includes all non-body entities that carry out
businesses for profit.

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 Body
any company;
any registered partnership;
any entity formed under foreign law resembling a
company or registered partnership
any public enterprise or public financial agency that
carries out business activities
Any body of persons, corporate or unincorporated
whether created or recognized under a law in force in
Ethiopia or elsewhere.
Any foreign body’s business agent doing business in
Ethiopia on behalf of the principle.
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 Scope of business profit tax
Ethiopian income tax system is based on the
principle of residence (worldwide income) as
opposed to Territorial (local income) and
citizenship.
 Any business or individual which is a resident
in Ethiopia pays tax on its world wide income.
 Any non-resident business or individual that
derives income in Ethiopia shall pay income tax
only on its Ethiopian income source (local
income).
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 Residency
An individual shall be resident in Ethiopia, if he::
has a domicile (permanent residence address)
within Ethiopia;
has an habitual abode (a place that he frequently
resides) in Ethiopia; and/ or
is a citizen of Ethiopia and lives abroad for a
consular, diplomatic or similar purposes of the
government of Ethiopia.
lives in Ethiopia for more than 183 days in a
period of twelve calendar months, whether
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continuously or intermittently.
 Special Notes
Residential status is determined at the end of
a tax period.
The residential status of a taxpayer in
Ethiopia is determined not for a particular
source of income but for all sources.
A resident in Ethiopia is considered as such
even though that person has a residency in
other countries at the same time.
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 Scope of business profit tax
A body shall be resident in Ethiopia, if it:
 has its principal office in Ethiopia;
 has its place of effective management in
Ethiopia; and/or
 is registered in the trade register of the
Ministry of Trade and Industry or Trade
bureau of the Regional Governments as
appropriate.
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 Categories of Taxpayers
The categorization of taxpayers depends upon the following

I. Annual turnover or annual sales

II. Maintenance of accounting records

III.Requirements for registered vouchers

IV.Number and types of financial statements to be

prepared for tax purposes

V. Declaration of Income and time of payment of tax

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 Category ‘A’ Taxpayers
Category ‘A’ Taxpayers shall include:
Any business having an annual turnover over Br
500,000;
Any company incorporated under the laws of Ethiopia
or in a foreign country
Legal requirements:
 Maintain accounting records
 Use registered vouchers
 Submit Balance sheet and a profit & loss statement
 The tax year is the fiscal year of the government.
 They shall submit the Tax Declaration Form within 4
months
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 Category ‘B’ Taxpayers
Category ‘B’ shall include any business having an annual
turnover over Br 100,000.
Legal requirements:

Maintain accounting records

Use registered vouchers

Submit only a profit and loss statement

They shall submit the Tax Declaration Form to the

Tax Authority within 2 months from the end of

11 the tax year
 Category ‘C’ Taxpayers

Category “C” Taxpayers include, unless already classified in

Categories “A” and “B”, a taxpayers whose annual turnover is

estimated by the Tax Authority as being up to Birr 100,000.

Maintaining books of accounts is encouraged but not

mandatory

Not required to use registered vouchers and to submit any

financial statement

The tax year is the government fiscal year and tax shall be
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 Tax Accounting Methods

A taxpayer shall account for its activities either on a

Cash or Accrual Basis for the purpose of tax.

However, a company shall account for tax

purposes only on an accrual basis.

Taxable business income shall be determined on the
basis of the income statement prepared as per GAAP
or IFRS, subject to the provisions of applicable
Proclamations and the directives issued by the Tax
Authority.
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 Business Profit Tax Rate

 Taxable Business Profit of a body is taxable at the rate of 30 %.

 Taxable business income of other taxpayers whose annual

turnover is more than Br 100,000 shall be taxed in accordance

with Schedule “C” of Proclamation 286/2002

 Presumptive Tax – is a predetermined amount of tax paid by

small businesses whose annual sales is Br 100,000 or less. The

tax is estimated by estimating annual sales (daily sales) as per

Regulation 78/2002.
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 Schedule “C”
BusinessBusiness
Profit
Taxable Business Income per Year
Tax Rate
Income Tax

TB Over Birr To Birr Tax Rate Deductions

1st 0 1,800 Exempt (0%) 0

2nd 1,800 7,800 10 180
3rd 7,800 16,800 15 570
4th 16,800 28,000 20 1410
5th 28,200 42,600 25 2820
6th 42,600 60,000 30 4950
7th 60,000 ***** 35 7950
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 Deductible Expenses (Allowable Deductions)
Generally, any Direct Costs and expenses of producing the Income

shall be deductible. (Purchasing, Mfg, selling,etc)

General and admin expenses connected with the business activities.

It includes:

 Insurance Expense

 Promotional Expense (local or out of the country)

 Commissions Expense (paid for services rendered to the business)

 Payment to Holding or Parent Company for services received

 Salaries expense (Not to partners or proprietors of the business)

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 Deductible Expenses : -Cont’d

Interest Expense but not exceeding Inter-Bank Rate + 2%

Donations and Gift Expense not exceeding 10% of the unadjusted taxable

income
Maintenance and Improvement Expense (i.e. if it is immaterial or

incidental) (As long as it doesn’t exceed 20% of Book Value)

Bad Debts Expense (Uncollectible Accounts Expense) – Direct write-off

method (if failed to collect legally)

Participation deduction (For reinvestment of profit by registered

partnership and Companies) not exceeding 5% of the UNADJUSTED

taxable income
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 Deductible Expenses : -Cont’d
 Special (technical) reserves for financial institutions

 Transportation Allowance paid to Employees not

exceeding the limit

 Retirement Benefits – less or equal to 15% of the basic

salary of the employee

 Representation Expense – 10% of basic salary of

employee
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 Trading Stock Disposed (Cost of Goods Sold) -
 Example : BIRTY Share Company has the following
beginning and purchase of merchandise Inventory
during the Tax Year 2006 (Assume a tax year from
Hamle 1 to Sene 30)
Date Particulars Quantity Unit Cost
Hamle 1, 2005 Beg Bal. 2,000 10
Tikmet 16, 2006 Purchase 2,600 11
Megabit 22, 2006 Purchase 3,000 10.5
Sene 13, 2006 Purchase 2,500 10.6

Required : determine the cost of trading stock

disposed during the tax year assuming that 2,700
units were on hand as of the end of the tax year.
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 Example 2
Glorious Company is a merchandising business that buys
and sells electronic and related items. The following data
is given relating to purchase of merchandise item #001 for
the tax year ended on Dec. 31, 2012.
January 1 Inventory 15,000 units @ Br 20
April 3 Sold 5,000 units
June 12 Purchased 10,000 units @ Br 22.50
August 22 Sold 15,000 units
Nov. 27 Purchased 10,000 units @ Br 25
Which of the following should be included in inventory of
a Co. for the tax year that ended on Sene 30, 2006.
a) A copy of a freight bill in the amount of Br 70,000
related to goods purchased on Ginbot 2006 was
received from the vendor on Hamle 15, 2006 after
physical count took place. The freight charge was not
included in the inventory of Sene 30, 2006.
b) 15,000 units of goods with total purchase cost of Br
210,000 shipped by the vendor at FOB shipping point
on Sene 25, 2006 were in transit on Sene 30, 2006.
They were not included in the physical count at the end
of the year.
c) 50,000 units shipped to a customer on Sene 29,2006 at
FOB destination were in transit on Sene 30,2006. They
were not included in the physical count.
d) From the goods shipped out on consignment to ABC Co.
(consignee) 70,000 units were not sold as of the inventory
date.
e) 5,000 units received from a supplier on Ginbot 27,2006
were damaged and awaiting return to the supplier.
f) The physical count at the end of the tax year ascertains
that the ending inventory includes 30,000 units of
damaged soap that may be saleable below their cost.
g) The physical count at the end of the year also ascertains
that the ending inventory includes 3,000 units of damaged
items that may not be marketable at all.
 Donations and gifts
 Donations and gifts are deductible only under the
following conditions.
1. If the donations are given to welfare organizations
2.  If the payments are made under emergency call issued
by Govt
3. If the payment is made for non- commercial education
or health facilities.
 (Note: Grants and donation will be allowed as deduction
only if it does not exceed 10% of the taxable income)

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 Depreciation Methods (Article 23)
Fine Art, Antiques, Jewelry, and Trading Stock and other

business assets not subject to wear and tear and obsolescence

shall not be depreciated.
 Building and Construction (Land Improvement): at 5% on straight

line basis. The acquisition or construction cost, and the costs of

improvement (ማሻሻያ), renewal (ማደሻ) and reconstruction (መልሶ
መገንቢያ) shall be depreciated each individually.

 Intangible assets: 10% (straight line basis). The acquisition (OR

construction cost), the cost of improvement, renewal and

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reconstruction costs shall be depreciated individually.
 Depreciation Methods: -cont’d
Computers, information systems, software products and

data storage equipment: 25% (on a pooling system

(declining balance method))
All other business assets (Eg. Machineries, furniture and

fixtures, vehicles, tools and spare parts, books, etc): 20%

(on a pooling system)
N.B. It is the date of acquisition of assets that is important not date
of putting into service. Besides, the principle of full year
depreciation
25 is used; not partial year depreciation. Finally,
 Depreciation Base under Pooling Method
Depreciation Base = BV Beginning + Cost of Assets Acquired

(acquisition, improvement, renewal, and reconstruction) – Disposal Value

(sale or insurance received for loss of Assets)
 If the depreciation base is a Negative Amount, that amount shall be added to

taxable profit and the depreciation base shall become zero.

 If the depreciation base does not exceed Br 1,000, the entire depreciation base

shall be a deductible business expense

 If expense incurred for the maintenance and improvement exceeds 20% of the

depreciation base, the whole amount will be added to the depreciation base of
the
26 category.
 Example 1
Alpha Co. has a building that was purchased for Br
10,000,000 on Megabit 22, 1999 and was placed in
service on Hamle 14, 1999. In Sene 2005, the company
made major structural repairs on the building at a cost of
Br 2,000,000. Construction of extension for workers’
canteen also took place in the same period at a cost of Br
550,000.
Required: What is the Accumulated depreciation as at
Hamle 1, 2004? What is the depreciation expense for the
tax year ending on Sene 30, 2005?

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 Example 2: Assume ABC PLC uses the tax year Hamle 1 to Sene 30 and has
the following assets: Computers, information system, software, and data storage.
Date of Purchase Acquisition Cost
Yekatit 10, 2003 Br 16,000
Ginbot 01, 2003 Br 6,000
Nehassie 07, 2003 Br 7,000
Tahisas 19, 2004 Br 3,500

Required: Compute depreciation base and depreciation expense for

the tax year ending on Sene 30, 2003, 2004, and 2005 assuming
that ABC Plc sold old computer at Br 3,000 on Megabit 23, 2005.

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 Example 3
 The following information relates to Zumra Company.
• The book value of the pooled machineries in the opening
balance sheet of the tax period as of Hamle 1, 2005 was
Br. 85,000.
• During the tax year 2006: Zumra bought additional
machines for Br. 50,000, received Br. 5,000 as
compensation from the vendor since one of the machines
does not work properly, paid Br 40,000 for maintenance
of a machine, and sold an existing machine for Br.
10,000.
Required: - Determine Deprn expense for the year ended Sene
30, 2006.
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 Disposal of Fixed Assets
For individually depreciating assets, gain or loss from the
disposal would be recognized by comparing the disposal
price of the asset with its book value at the time of
disposal. But, loss wouldn’t be recognized if the disposal
transaction is carried out between related persons.
For business assets that depreciate in a pool, gain or loss
from disposal is not allowed for income tax purposes.
However, the cost and accumulated depreciation of the
asset disposed of must be written off from the accounting
records of the business in the following year of the
disposal year.

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Example 4: The following information relates to ABC Co. for a pool
of machineries:
The cost and Accumulated depreciation of the pool of machineries
on Hamle 1, 2004 were Br 582,000 and Br 500,000, respectively.
The firm acquired new machinery for Br 50,000 on Sene 10, 2005
and sold the following three machineries in the tax year of 2005.

Date of sale Acquisition Acc. Deprn Selling Price

Nehassie 10, 04
120,000 98,000 31,800
Ginbot 5, 05 80,000 72,000 52,000
Sene 10, 05 95,000 90,000 48,000
295,000 260,000 131,800
Required: Determine depreciation expense of the pool for the tax
year ending on Sene 30, a) 2005 and b) 2006. Assume that there
was no acquisition or disposal of machineries in the tax year of
2006.
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 Treatment of Interest Expense
Interest expense (Max. = Interbank rate + 2%) is
allowable for deduction only if:
a) It arises from borrowings from institutions
recognized by NBE (interest on trade payables is not
recognizable)
b) Arises from borrowing from a foreign bank under
the permission of NBE and the foreign bank is
required to file a written declaration to the tax
authority about the loan to be granted. (10% of the
interest should be withheld and be paid to the taxing
authority within 2 months of the end of the tax year)
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 Treatment of Interest Expense
c) It arises from borrowings from the owners of
the organization (body). The loan should not
exceed 4 times the average share capital
(basic capital or paid up capital) during the
tax year. If the capital exceeds this level the
whole interest payable to the shareholders
would not be deductible.

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 Non-Deductible Expenses

The cost of depreciable business assets (capital expenditures)

Entertainment (food, beverage, tobacco, accommodation,

amusement, recreation or any type of hospitality to any person)

Personal consumption expenses of the owner paid by the business

Declared dividends and paid-out profit shares

Damages covered by insurance policy (Damages not covered would

be allowed)

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 Non-deductible Expense (
Punitive damages (by court) and penalties

Input VAT (recoverable tax) and income tax

expenses
Expenditures exceeding the legal limits

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 The following categories ofExemptions
income shall be exempt from
payment of business income tax hereunder:
 Awards for adopted or suggested innovations and cost saving

measures
 Public awards for outstanding performance

 Income specifically exempted from income tax by the law in

force in Ethiopia, by international treaty or by an agreement

made or approved by the Ministry of Revenue

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 Exemptions…. (Cont’d)
The revenue obtained by the Federal
Government, Regional Governments and Local
Governments of Ethiopia; and the National
Bank of Ethiopia from activities that are
incidental to their operations.

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 Accounting for Business Profit Tax

 For bodies, apply a flat 30 % rate on the taxable profit

 For other tax payers (except category C) use the following

formula
TB Over Br To Br Tax Rate Deduction

1st 0 1,800 Exempt 0.00

2nd 1,800 7,800 10% 180.00
3rd 7,800 16,800 15% 570.00
4th 16,800 28,000 20% 1410.00
5th 28,200 42,600 25% 2820.00
6th 42,600 60,000 30% 4950.00
7th 60,000 ***** 35% 7950.00

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 Computing BIT: Examples

Example 1: SHALA Merchandising Enterprise is a Category

“B” taxpayer. The enterprise reported Br 300,000 sales
revenue; Br 200,000 Cost of goods sold and Br 62,000
operating expenses during the tax year ending Sene 30, 1997.

Required: Determine the Taxable Business Income and

Business Profit Tax to be paid.

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 Special Items that Reduces Business Profit Tax

Business profit tax is adjusted for factors :

Loss Carry Forward and Loss Carry Back

Withholding of Business Profit Tax;

 Foreign Income Tax Credit

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 Loss Carry Forward and Loss Carry Back
Loss Carry Back is a tax provision that allows

operating losses to be used as a tax shield to reduce

taxable income in prior periods.
Loss Carry-Forward is a tax provision that allows

operating losses to be used as a tax shield to reduce

taxable income of the future years.
According to Article 28 of the Proclamation loss
may be carried forward where the books of account
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showing the loss are acceptable to the Tax Authority
 Loss Carry Forward and Loss Carry Back

If there is a loss in any year, it can be off set against taxable income

in the next three years.

A loss may be carried forward only for two periods of three years.

In the process of carry forward, earlier losses should be off set

before later losses.

For Construction companies loss may be carried forward and any

loss that is not off set after carry forward may be carried back to

previous years.
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 Example: The following relates to taxable
income for three different companies.
Comp Taxable Income (loss) for year
any
1998 1999 2000 2001 2002 2003 2004 2005

ABC (100,000) 80,000 12,000 5,000 50,000 90,000 100,000 110,000

XYZ (50,000) 5,000 25,000 10,000 (40,000) 10,000 50,000 60,000

MAR (100,000) 90,000 (60,000) 45,000 (150,000) 40,000 170,000 100,000

Y

Required: Determine the taxable liability

for each of the companies for each year?
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 Withholding Income Tax
 Withholding Income Tax: is an advance payment of business
income tax by a business at the time of importing trading goods
or at the time of receiving payment for sale of goods or services
locally.
 Withholding tax paid shall be deducted from business profit tax.
Withholding tax rates
 On imported trading goods- 3% of CIF (whether the freight paid by the
importer or not doesn’t matter)
 On Payments for goods and services transacted locally- 2% of the gross
amount of the payment (excluding VAT).

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 Withholding scheme on local transaction

Supply of goods involving more than Birr

10,000 in any one transaction or one supply
contract
Rendering of the certain services involving
more than Birr 500 in any one transaction or
one service contract.

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 Foreign Tax Credit

Foreign tax credit refers to reduction of business



profit tax for income tax paid in foreign country

from foreign source income.


Businesses can take advantage of foreign tax

credit as per Art. 7 or Proclamation No.286/2002

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 Computation of TBI from GAAP Based Financial
Statements

If the tax payer has deducted any expense which is non-

deductible, then such amount is to be added back.

if the tax payer has not claimed any expense that is deductible,

then such amount is to be deducted

Amount
Particulars In ETB
Taxable Business Profit from GAAP Based Income Xxx
Statement
Add: Non-Deductible Expenses (If they are deducted) xxx
Less: Allowable expenses (if not claimed) (xxx)
Taxable
47 Business Profit for tax purpose xxxx
 Preparation of Tax Returns

The tax returns shall be accompanied by:

The amount of business profit tax payable in

check or in cash,

Tax vouchers and documents, and

any other relevant information

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 Comprehensive Illustration:
 The following transactions are given for the tax year Hamle
1st, 1998 to Sene 30th, 1999 for AMT General Trading Pvt.
Ltd. Co.:
Sales during the tax year is Br 2,320,000
Inventory account balance:
Beginning 26,000 units @ Br.20 a unit
purchased during the year 70,000 units @ Br.22 a unit
Ending ( Sene 30, 1999) 26,600 units
Promotional expense of Br 83,000 was incurred which
comprises Br 38,000 advertising expense; Br 25,000 trading
coupons and Br 20,000 entertainment expense.

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 Illustration…(Cont’d)
Salary expense of Br 165,000 was incurred and
composed of Br 100,000 basic salary; Br 25,000
provident fund contribution; Br 20,000 representation
expense and Br 20,000 overtime payment
Store Rent Expense of Br 240,000 was also incurred
Br 21,000 interest is paid on Br 100,000 principal
amount of loan where the interest rate between
NBE and Commercial Banks is 9%
Penalties paid by the business is Br 1,360

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 Illustration- cont'd
Building has a cost of Br 500,000 and has not
depreciated before the tax year 1999
Truck has a carrying amount of Br 120,000 on
Hamle 1st, 1998.
Computers, Information System, Data Storage
and Software have a balance of Br 69,000 on
Hamle 1st, 1998. During tax year the business
enterprise acquired and disposed Br 32,000 and
39,000 assets, respectively
Br 80,000 award for outstanding performance
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was received from the government
 Illustration- cont'd
The business incurred Br 100,000 expenses on behalf of
the owners
Donation of Br 50,000 was made by the business to charity
organization with successful achievement and transparent
system.
Withholding income tax receivable has a balance of Br
23,800 at the end of tax year 1998
Br 50,000.00 loss was carried forward to tax year 1999
from the tax year of 1998.
Required:
Prepare income statement for tax purposes for tax year
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ending Sene 30, 1999 as per Ethiopian tax law
 End of the Unit

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